The World Needs More Debt

Let’s say you walk into a dealership looking to buy a new car. You’re expecting to pay 5% interest on a loan, but the salesperson looks over your credit profile and offers 0% financing on any model. Would you be more likely to buy a nicer, more expensive car? Of course you would! Interest payments are zero, you get to cruise around in a nice ride, and the vehicle’s resale value will probably be higher than a lesser model. What if the dealership paid you to take a loan? Would you buy an even more expensive car? These aren’t trick questions; any logical consumer would spring for an upgrade. And yet, western governments are seemingly content with their 1988 Civic when they should be pricing out Ferrari’s (RACE).

Bond markets are sending strong signals that there is too little, rather than too much, outstanding government debt. The supply of European sovereign debt is so limited that the ECB is actually constrained in its ability to ease monetary policy further. Germany is being paid to borrow money out to five years, yet policymakers still seem hell-bent on fiscal austerity. You can get a 35-year mortgage in Japan for 1.6%. If the US debt-to-GDP ratio of 50% was appropriate in 2007 when 10-year Treasury’s yielded 5%, it should be much higher than 85% now with the yields at 2%.

QE and ZIRP are designed to spur investment and consumption, but it’s just not happening. Those policies can be effective at weakening currencies, taking some pressure off the local economy, but this merely transfers those pressures to other countries; the net impact to global aggregate demand is zero. Seven years after the Financial Crisis, leverage is higher than ever, yet global demand might not be strong enough to prevent a recession.

The world’s most liquid markets are telling us that we’re in uncharted territory, where deflation poses a much greater threat than inflation. The obvious solution is to blow out spending on infrastructure and maintenance across the developed world. Is that going to happen? It’s already happening in China, where the government authorized its policy banks to issue 1 trillion RMB of new bonds designated for infrastructure. Unfortunately, China’s problems have more to do with an excessively strong currency than poor infrastructure.

The world’s two largest economies, the US and EU, both badly need upgrades but operate as democracies. China can put a lot of capital to work quickly once the government signs off on a project. Western democracies operate slowly in comparison. As it stands, EU officials are busy dealing with over 1 million asylum-seekers and seem content with Germany’s austerity mandate. The US Congress has almost no ability to pass meaningful legislation, and Republicans can’t even find a taker for the position third in line to the presidency. Of course, nothing makes it easier to form a consensus than panic. Once financial markets turn significantly lower fiscal stimulus will once again be a viable option. In the meantime, buckle up.